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    Capital Asset Pricing Model

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    Amandeep Singh Manku
    The Capital Asset Pricing Model (CAPM) describes the relationship between risk and expected return used to price risky securities. It holds that the expected return of an asset equals the risk-free rate plus a risk premium based on the asset's beta, which measures its volatility relative to the market. Using CAPM, if a stock's beta is 2 and the market return is expected to be 10% with a risk-free rate of 3%, the stock's expected return is 17%. Beta quantifies an asset's systematic risk by how its returns respond to market movements, with a beta of 1 indicating average volatility.

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    Capital Asset Pricing Model

    Uploaded by

    Amandeep Singh Manku
    53 views2 pages
    The Capital Asset Pricing Model (CAPM) describes the relationship between risk and expected return used to price risky securities. It holds that the expected return of an asset equals the risk-free rate plus a risk premium based on the asset's beta, which measures its volatility relative to the market. Using CAPM, if a stock's beta is 2 and the market return is expected to be 10% with a risk-free rate of 3%, the stock's expected return is 17%. Beta quantifies an asset's systematic risk by how its returns respond to market movements, with a beta of 1 indicating average volatility.

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    CAPM model

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    The Capital Asset Pricing Model (CAPM) describes the relationship between risk and expected return used to price risky securities. It holds that the expected return of an asset equals the risk-free rate plus a risk premium based on the asset's beta, which measures its volatility relative to the market. Using CAPM, if a stock's beta is 2 and the market return is expected to be 10% with a risk-free rate of 3%, the stock's expected return is 17%. Beta quantifies an asset's systematic risk by how its returns respond to market movements, with a beta of 1 indicating average volatility.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    53 views2 pages

    Capital Asset Pricing Model

    Uploaded by

    Amandeep Singh Manku
    The Capital Asset Pricing Model (CAPM) describes the relationship between risk and expected return used to price risky securities. It holds that the expected return of an asset equals the risk-free rate plus a risk premium based on the asset's beta, which measures its volatility relative to the market. Using CAPM, if a stock's beta is 2 and the market return is expected to be 10% with a risk-free rate of 3%, the stock's expected return is 17%. Beta quantifies an asset's systematic risk by how its returns respond to market movements, with a beta of 1 indicating average volatility.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
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    Capital Asset Pricing Model - CAPM

    What Does Capital Asset Pricing Model - CAPM Mean?


    A model that describes the relationship between risk and expected return and that is used in
    the pricing of risky securities.

    The general idea behind CAPM is that investors need to be compensated in two ways: time
    value of money and risk. The time value of money is represented by the risk-free (rf) rate in
    the formula and compensates the investors for placing money in any investment over a
    period of time. The other half of the formula represents risk and calculates the amount of
    compensation the investor needs for taking on additional risk. This is calculated by taking a
    risk measure (beta) that compares the returns of the asset to the market over a period of
    time and to the market premium (Rm-rf).

    Investopedia explains Capital Asset Pricing Model - CAPM


    The CAPM says that the expected return of a security or a portfolio equals the rate on a
    risk-free security plus a risk premium. If this expected return does not meet or beat the
    required return, then the investment should not be undertaken. The security market line
    plots the results of the CAPM for all different risks (betas).

    Using the CAPM model and the following assumptions, we can compute the expected
    return of a stock in this CAPM example: if the risk-free rate is 3%, the beta (risk measure) of
    the stock is 2 and the expected market return over the period is 10%, the stock is expected
    to return 17% (3%+2(10%-3%)).
    What Does Beta Mean?
    A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to
    the market as a whole. Beta is used in the capital asset pricing model (CAPM), a model that
    calculates the expected return of an asset based on its beta and expected market returns..

    Also known as "beta coefficient".

    Beta
    Beta is calculated using regression analysis, and you can think of beta as the tendency
    of a security's returns to respond to swings in the market. A beta of 1 indicates that the
    security's price will move with the market. A beta of less than 1 means that the security will
    be less volatile than the market. A beta of greater than 1 indicates that the security's price
    will be more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically
    20% more volatile than the market.
    Many utilities stocks have a beta of less than 1. Conversely, most high-tech Nasdaq-based
    stocks have a beta of greater than 1, offering the possibility of a higher rate of return, but
    also posing more risk.

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